Two years earlier, Insight employees, their friends and family paid $3 million for 20% of the fast-growing company. The group made more than 15 times its money on the investment, banking more than $40 million, according to documents reviewed by The Wall Street Journal. The firm's co-founders,
Jeff Horing
and
Jerry Murdock,
invested $300,000 apiece. Each banked nearly $5 million when News Corp.'s Fox Interactive Media bought Photobucket.

But investors in Insight's technology fund -- so-called limited partners such as the California Public Employees' Retirement System and Yale University's endowment -- made nothing. They didn't participate in the investment in Photobucket, and weren't given the chance to do so.

"The investment was made in full compliance with the letter and spirit of all of Insight's agreements with its limited partners," said
Ilan Nissan,
a partner with O'Melveny & Myers LLP, a law firm that regularly represents Insight.

The windfall earned by Insight executives -- but not the firm's investors -- highlights a dicey game: fund executives who invest in deals personally, but not through the funds they manage. Private-equity, venture-capital and hedge-fund firms all wrestle with the potential conflicts of interest inherent when executives -- the so-called general partners -- invest in deals personally rather than through their funds.

Many large private-investment funds have lawyers or compliance officials vet personal investments to ensure that fund executives aren't usurping investment opportunities of the fund. While each fund's rules vary, many allow executives to make personal investments in certain circumstances.

For instance, some firms permit personal investments in areas that fall outside the scope of a fund's strategy. So, a general partner who runs a fund that invests in Indian technology companies might be permitted to invest personally in a U.S. financial-services deal. Also, some funds allow executives to invest in a deal after a fund has committed its maximum allocation to the investment.

Nevertheless, fund lawyers acknowledge that a conflict exists whenever executives pass the hat around among themselves but not to their investors. The issue can be particularly fraught at venture-capital firms, where the typical investment size is often smaller and more affordable for an individual than those made at, say, private-equity firms that do multibillion-dollar buyouts.

The risk is that fund managers could be viewed as cherry-picking deals for themselves, lawyers say.

That wasn't the case with Photobucket, Insight's Mr. Horing says. He describes Photobucket as an early-stage Internet start-up that fell outside the investment guidelines laid out in Insight's fund documents. Insight, which has about $3 billion under management, makes later-stage, so-called expansion investments in Internet and other technology companies, often taking a controlling interest. The firm's average investment size is about $35 million, Mr. Horing says. Companies in which Insight invests have average revenue of about $25 million, he says.

Photobucket didn't come close to meeting those criteria, Mr. Horing says. The free photo-sharing company, founded in 2003, was less than two years old and had three employees when Insight bought a 20% stake. It was generating only nominal revenue through advertising and premium photo-sharing services. But Photobucket was growing like a weed -- it had roughly 5.5 million members and was increasing its membership by roughly 15% a month.

One prominent investor in Insight's funds says that "perhaps they should have told us about this, but it was such a small deal. Would we have wanted a piece of it in hindsight? Sure. But for every one of these successes, there are a hundred failures."

"I didn't spend more than 30 minutes on this deal," Mr. Horing says. "It looked like it was worth a flier, so we invested personally and got lucky."

Once they invested, Insight executives did spend more than half an hour on Photobucket. At the very least, firm executives helped pitch other venture-capital firms on investing in subsequent rounds, including Kleiner, Perkins, Caufield & Byers and Benchmark Capital. Both declined to invest. Also, according to a person familiar with the talks, Insight was involved in Photobucket's negotiations with Fox Interactive, which, like Dow Jones & Co., publisher of the Journal, is owned by News Corp.

Fund lawyers say that LPs watch closely the time spent and the attention that mangers devote to their funds, versus matters falling outside the funds. Mr. Horing says that the firm used few resources on the deal, spending a total of about 15 hours of time on the investment.

Insight didn't formally notify its investors about its Photobucket investment, Mr. Horing says. But after Fox Interactive announced its acquisition, some media outlets reported that Insight had backed Photobucket. This prompted questions from investors. None had any problems with the Photobucket deal, Mr. Horing says. "They just didn't care."

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